Fixed income may defy conventional thinking and customary behavior. After all, instant gratification and outsmarting traditional methods seem to be part of the American DNA. The desire to take the shortcut path to the finish line can seem irresistible and often cloud strategic financial planning. We frequently hear commentary in the media that suggests there is never a bad time to buy stocks. Either the stock market is roaring higher and one needs to participate in the rally, or it is pulling back, making it a good time to dollar-cost-average and prepare for the next rally.
As an advocate for overall healthy financial planning, I believe different products make distinct contributions to sound financial strategic planning. My goal is to remind you of the importance and benefits of fixed income as a crucial component of a well-diversified portfolio.
Growth is not the primary purpose of individual bonds and therefore operates counter to our desire for instant gratification or desire to outdo the average. The primary purpose of fixed income is generally not to generate wealth, but rather to help preserve existing wealth. In the current economic environment, this is of utmost importance. Equity holdings have risen far above many experts' expectations. Bonds provide a way to lock in or preserve that increase in wealth. A strategy that’s been working for many investors is to allocate a portion of their equity earnings to bonds. The base capital continues to work in equities, while profits are reinvested in less risky bonds.
This diversification of assets and purpose exists whether we are in a 1% or 10% interest rate environment. What is particularly relevant now is that we are in an environment of elevated interest rates. Bonds currently serve a dual mandate of wealth preservation and income generation. It is a good opportunity to capture a healthy income stream in less volatile and more conservative bonds. The current interest rate environment enables investors to achieve returns exceeding 4.5%. Most yield curves are upward sloping, thus providing investors with even higher yields as they extend out in maturity.
It can be fun to outwit the average and overweight the trend, but the opportunity to help preserve accumulated wealth and continue to produce elevated returns via individual bonds makes for a compelling financial strategy.
